HAND OUT # 06:

FINANCIAL & ACCOUNTING MANAGEMENT

KASHIF NOOR (ASSIST. PROFESSOR)

MECHANICAL ENGINEERING DEPARTMENT

Cost Concept
Cost : The value of the sacrifice made to acquire goods or services. All costs of a manufacturing
organization may be divided according to functional areas into (i) manufacturing cost (ii)
Marketing cost (iii) Administrative cost (iv) Financing cost.

(i) Manufacturing cost : These are related to the production of an item. They are the sum
of direct material , direct labour and factory overhead cost.
(ii) Marketing cost : These are incurred in promoting a product or service.
(iii) Administrative cost :These are incurred in directing , controlling and operating a
company and includes salaries paid to management and staff.
(iv) Financing cost :These are related to obtaining funds for the operation of the
company.They include the cost of interest that the company must pay on loans,as well
as the cost of providing credit to customer.

Expense : A cost that has given benefit and is now expired.

Elements of a Product

The cost elements of a product or its integral components are direct materials, direct labour and
factory overhead.

Fig 1-5 on page 15

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Materials : These are the principal substances used in production that are transformed into
finished goods by the addition of direct labour and factory overhead. The cost of materials may
be classified into direct and indirect materials as follows:

Direct materials: All materials that can be identified with the production of a finished product ,
that can be easily traced to the product and that represent a major material cost of producing that
product.An example of direct material is the lumber used to build a bunk bed.

Indirect material: All materials involved in the production of a product that are not direct
materials . Indirect materials are included as a part of factory overhead. An example of indirect
material is the glue used to build a bunk bed.

Labor cost: Labor is the physical or mental effort expended in the production of a product.
Labor costs may be divided into direct and indirect labor as follows:

Direct Labor: All labor directly involved in the production of a finished product that can by
easily traced to the product and that represents a major labor cost of producing that product.The
work of machine operators in a manufacturing company would be considered direct labor.

Indirect Labor:All labor involved in the production of a product that is not considered direct
labor. Indirect labor is included as part of factory overhead. The work of a plant supervisor is an
example of indirect labor.

Factory Overhead:

This all inclusive cost pool is used to accumulate indirect materials, indirect labor and all other
indirect manufacturing costs which cannot be directly identified with specified products.
Examples of factory overhead costs beside indirect materials and indirect labor are rent , light
and heat for the factory and depreciation of factory equipment.

Prime cost Conversion cost

Direct Material Direct Labor Factory

overhead

Prime Cost : Prime cost are direct materials and direct labor. Prime costs are directly related to
production

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Conversion cost : These are costs concerned with transforming direct materials into finished
products. Conversion cost are direct labor and factory overhead

Fixed cost : Those costs which in total remain constant over a relevant range of output while the
cost per unit varies inversely with output. Beyond the relevant range of output , fixed cost will
vary. Upper management controls the volume of production and is therefore responsible for fixed
costs.

(i) Non-recurring fixed cost (One time cost like plant construction cost)

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(ii) Recurring cost (Repetitive fixed cost like administrative level salaries ,taxes , interest
coston borrowed capital)

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 Variable cost : Variable costs are those in which the total cost changes in direct proportion
to change in volume or output within the relevant range ,while the unit cost remains constant.
Variable cost are controlled by the department head.Those costs which change in total in
direct proportion to changes in volume and whose unit cost remains constant, within the
relevant range.

Example : Raw material cost

For e.g; if variable cost for direct material are $100 per unit of output, each time output increases
by one unit, the variable cost for direct material will increase by $100

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Cost Estimation Approaches :

(i) Bottom up approach :

Treats the final cost as an independent (output) variable and the associated cost as
input or dependent variable.
 Cost components are first identified
 Required Price = Direct cost + total indirect cost + desired Profit
 Traditional costing approach
 Applied in industries where competition is not the dominant factor in pricing
the product or the service or It is used for new product.

(ii) Top down approach :

Treats the competitive cost as an input variable and the associated cost astimates as
the output variables

 It is used for competitive market or applied in the early stages of new or

enhanced product design.
 It is also called “Design-to-cost” approach
 Price estimates are conducted to set “target” values.
 Target Price = Direct cost + total indirect cost + Allowed Profit

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Cost of Good Manufactured (COGM)

Prepare a statement of cost of good manufactured for ABC Company.

Labou
Raw Materal (Direct Material) r Cost
Direct - - - -
Inventory ,January 1 - - - - - $ 9000 - $19000
Indirect - - -
Inventroy , December 31 - - -$12000 - $ 17000

Additional information :
Heat and electricity for the factory - - - - - - - - - - - - -$ 25000
Material purchased during the year - - - - - - - - - - - - - $ 40, 000

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Cost of goods in process during the year - - - - - - - - - - $ 103.000
Work in -process inventory ,December 31st - - - - - - - - $ 7000
Sales - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - $ 125000
Finished good inventory, January 1st - - - - - - - - - - - - $ 25000
Cost of good sold - - - - - - - - - - - - - - - - - - - - - - $ 105000
Selling ,general and administrative expenses - - - - - -- - - $ 11000

ABC company
Cost of goods man ufactured statement
For the year ended __Dec 31st, 2013_________

Direct material
Opening raw material (Jan 1st)
Purchases
Purchase discount
Net Purchases
Freight in
Raw material available for production
Ending raw material

Raw material consumed

Direct labour

Manufacturing Overhead
Indirect labour
Heat and electricity for the factory

Total manufacturing overhead

Total Manufacturing cost for the period

Beginning WIP ($103,000 - $ 98,000)

Total WIP Inventory

Ending WIP

Cost of Good Manufactured

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Product costing

Q The Acme Plastic Co. has two processing departments . All direct masterials are added in Department1
at the beginning of the process . Converwsion costs are incurred evenly throughout both processes .
Data for Januar 20XX are shown below:

  Department 1 Department 2
Units started in process 75000  
Units transferred to next department 60000  

Units transferred to fininshed goods    

Inventory   5000
1500 500
Ending units in process 0 (60% completed) 0 (80% completed)

Costs added by department        

Direct materials 300000  
Direct Labour 172500 162250
Factory overhead 86250 81125

No beginning worl-in-process inventory exists. Prepare a cost of production report for both department

Solution

Department 1 :

Step 1 : Quantity Schedule

Units started in process   75000

     
Completed 60000  
WIP Closing 15000  
    75000

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 Step 2 : Equivalent Production

  Direct Materials Conversion Cost

     
Completed 60000 60000
WIP Closing 15000 9000

  75000 69000

Step 3 : Cost of Production Report

  Total cost Equivalent cost Unit cost

Direct Material 300000 75000 4.00
Direct Labour 172500 69000 2.5
Factory Overhead 86250 69000 1.25
Total cost to be accounted for 558750   7.75

Step 4 : Total cost accounted for as follows

       
Finished good 60000 X 7.75 465000
   
WIP Closing  
Direct Material 15000 X 4 60000  
Direct Labour 9000 X 2.50 22500  
Factory Overhead 9000 X1.25 11250  
  93750
   
  558750
       

Department 2

Step 1 :Quantity Schedule

Units received from previos department   60000

     
Completed 55000  
WIP Closing 5000  
    60000

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 Step -2 : Equivalent Production
  Direct Materials Conversion Cost
     
Completed   55000
WIP Closing   4000

  0 59000

Step -3 Cost of Production Report

  Total cost Equivalent cost Unit cost

Direct Material 0 0  
Direct Labour 162250 59000 2.75
Factory Overhead 81125 59000 1.375
Total cost to be accounted for 243375   4.13

Step -4 : Total cost accounted for as follows

       
Finished good 550000 X 4.13 226875
   
WIP Closing  
Direct Material 0  
Direct Labour 4000 X 1.375 11000  
Factory Overhead 4000 X1.375 5500  
  16500
   
  243375
       

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 Financial Accounting
C la ssifi ca ti o n o f A cco u n ts

Real account

Nominal account

Personal account

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DOUBLE ENTRY SYSTEM:

JOURNAL

JOURNAL STEPS:

1. . Identify the two accounts.

2. The identified a/cs should be classified as to real a/c , personal a/c or nominal a/c.

3. Find out the rules of Debit and credit

4. Identify which a/c is to be debited and which a/c is to be Credited .

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 Inventory
Post the below transactions in the inventory subsidiary ledger records and calculate (i) Cost of good sold
(ii) Ending inventories through (a) FIFO (b) Weighted Average method

Date Activity Units Rate Amount

1-Jan Purchases 8000 14.00 112000
5-Jan Sold 5000 20.00 100000
10-Jan Purchases 3000 16.00 48000
15-Jan Sold 4000 22.00 88000
20-Jan Purchases 5000 18.00 90000
25-Jan Sold 3000 22.50 67500
29-Jan Sold 3000 21.00 63000

Solution

1. FIFO

Purchases Sold Balance

Date Unit Rate Total Unit Rate Total Unit Rate Total
             
1-Jan 8000 14 112000     8000 14 112000
5-Jan     5000 14 70000    
          3000 14 42000
10-Jan 3000 16 48000     3000 16 48000
             
          6000   90000
15-Jan     3000 14 42000    
      1000 16 16000      
          2000 16 32000
20-Jan 5000 18 90000     5000 18 90000
          7000   122000
25-Jan     2000 16 32000    
      1000 18 18000    
          4000 18 72000
29-Jan     3000 18 54000    

          1000 18 18000
Total 16000   250000 15000   232000      

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 2. Weighted Average:

Purchases Sold Balance

Date Unit Rate Total Unit Rate Total Unit Rate Total
             
1-Jan 8000 14 112000     8000 14 112000
5-Jan     5000 14 70000    
          3000 14 42000
10-Jan 3000 16 48000     3000 16 48000
             
          6000 15.00 90000
15-Jan     4000 15.00 60000    
          2000 15.00 30000
20-Jan 5000 18 90000     5000 18 90000
          7000 17.14 120000
25-Jan     3000 17.14 51428.57    
        0    
          4000 17.14 68571.43
29-Jan     3000 17.14 51428.57    

          1000 17.14 17142.86

Total 16000   250000 15000   232857.1      

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 3. Periodic inventory system:

a From Purchases  
Total units available for sale (= total purcahse
  unit) 16000
  Total cost of purchase (purcahse unit X Rate) 250000
     
b Units in Ending Inventory 1000
  (as per physical count)  
     
c Total units sold during the period 15000
     
(i) FIFO Method  
  Cost of Ending inventory (100 @18) = 18000
  Cost of good sold (250000-18000) = 232000
     
(ii) Weighted Average Method  
  Cost of Ending inventory (1000 @ [ 250000 /16000] ) = 15625
  Cost of good sold ( 250000 - 15625 ) = 234375
     

Note
:
(i) Answer for FIFO and LIFO is same in periodic inventory system
(ii) Answer for weighted average is different in periodic inventory system

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